AN ANALYSIS OF CORPORATE RELATED-PARTY DISCLOSURE IN …eprints.qut.edu.au/60847/1/Zuni_Barokah_Thesis.pdf · 2014. 5. 2. · AN ANALYSIS OF CORPORATE RELATED-PARTY DISCLOSURE IN

AN ANALYSIS OF CORPORATE RELATED-PARTY

DISCLOSURE IN THE ASIA-PACIFIC REGION

By

Zuni Barokah

B.Ec. Universitas Gadjah Mada Indonesia

M.Com. (Advanced Accounting) University of New South Wales

Principal Supervisor: Professor Gerry Gallery

Associate Supervisor: Professor Natalie Gallery

A thesis submitted in fulfilment of the requirements for the degree of

Doctor of Philosophy

The School of Accountancy

Faculty of Business

Queensland University of Technology

Brisbane, Australia

2013

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ABSTRACT

Related-party (RP) transactions have been widely criticised for contributing to

wealth destruction and corporate failure. While it is argued that RP transactions are

normal business activities that fulfil corporate economic needs, prior research

suggests that many RP transactions appear to be used opportunistically to transfer

assets or liabilities between related parties. Thus, transparent RP disclosure is

warranted for effective monitoring of such transactions. Yet despite the criticisms

there has been a scarcity of research internationally and, in particular, in emerging

economies where disclosure transparency is often questionable. To address this gap,

the aim of this study is to investigate the nature and extent of RP disclosure and

identify factors which explain the variation in disclosure across the Asia-Pacific (A-

P) region.

Based on an analysis of institutional differences in the A-P region and agency theory,

it is argued that factors associated with stronger internal and external corporate

governance influence RP transactions usage and their disclosure transparency.

Importantly, a number of institutional factors which have been associated with more

transparent disclosure (common law origin, stronger regulatory enforcement and

investor protection, and controls for corruption) in other contexts are also expected to

enhance firms’ RP disclosures. Hypotheses are developed for each major governance

and institutional factor.

To capture expected regional differences in RP disclosure transparency and

institutional factors, a sample of 582 listed companies was selected across six

countries (Australia, Indonesia, Malaysia, the Philippines, Singapore and Thailand).

The sample ensured a wide coverage of companies that differ in legal origin,

enforcement, shareholders’ protection, and level of corruption. RP disclosures and

other firm-specific data were hand-collected from the 2009 annual reports. The

research questions were addressed and hypotheses tested using RP disclosure indices,

and descriptive-comparative and multivariate analysis methods.

The results indicate that RP transactions are very common across Asia-Pacific

countries, with related party loans the most common type of transaction. Importantly,

factors associated with better internal and external governance contribute to improve

disclosure scores. With respect to country-level characteristics, companies in a

country with stronger enforcement and control for corruption are associated with

more transparent disclosure of RP transaction information. Contrary to expectations,

the strength of a country’s investor protection has an inverse relationship with RP

disclosure. However, when a more specific measure of investor protection (an anti-

self-dealing index) is used, the findings show a positive association between the

index scores and RP disclosure. Taken together, the evidence suggests that country-

level factors, including the strength of enforcement by accounting regulatory bodies,

the protection of minority shareholders against self-dealing actions, and the control

for corruption influence RP disclosure transparency.

This thesis makes a number of important contributions. First, it is among the first to

comprehensively investigate the nature and extent of RP transactions in a cross-

country setting. Second, this study provides empirical evidence of an association

between financial reporting and corruption in a cross-country setting. This finding

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supports previous studies in other areas which find that corrupt actions are more

likely to be discovered when there is greater business transparency. Finally, the study

offers empirical evidence about corporate RP disclosure practices that may assist

regulators to introduce more focused compliance programs and more effective RP

disclosure guidelines and regulations.

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TABLE OF CONTENTS

ABSTRACT ............................................................................................................................ ii

TABLE OF CONTENTS ..................................................................................................... iv

LIST OF TABLES .............................................................................................................. viii

LIST OF FIGURES ................................................................................................................ x

LIST OF ABBREVIATIONS .............................................................................................. xi

STATEMENT OF ORIGINAL AUTHORSHIP............................................................... xii

ACKNOWLEDGEMENTS ............................................................................................... xiii

CHAPTER 1: INTRODUCTION .......................................................................................... 1

1.1. Research Motivations ..................................................................................................... 2 1.2. Research Questions ......................................................................................................... 4 1.3. Theoretical Framework and Hypotheses ........................................................................ 4 1.4. Research Design ............................................................................................................. 6

1.4.1 Definition of Terms Used for RP Transactions and RP Disclosures .................... 7 1.4.2 Scope of Accounting Regulations ........................................................................ 8

1.5. Main Findings ................................................................................................................. 8 1.6. Contributions ................................................................................................................ 11 1.7. Organisation of the Study ............................................................................................. 13

CHAPTER 2: INSTITUTIONAL SETTING ..................................................................... 14

2.1. Country Factors Associated with RP Disclosures ........................................................ 15 2.1.1 Legal Origin ....................................................................................................... 18 2.1.2 Capital Market Development ............................................................................. 19 2.1.3 Enforcement, Investor Protection and Control for Corruption ........................... 20

Enforcement ........................................................................................................ 20 Investor Protection ............................................................................................. 22 Control for Corruption ....................................................................................... 24

2.1.4 Ownership Concentration ................................................................................... 24 2.1.5 Corporate Governance Principles ....................................................................... 26 2.1.6 Summary of Institutional Factors Affecting RP Disclosures ............................. 30

2.2. Evolution of IAS 24 Related Party Disclosures ........................................................... 30 2.3. RP Disclosure Standards in the Asia-Pacific Countries ............................................... 35

2.3.1 Australia ............................................................................................................. 36 2.3.2 Indonesia ............................................................................................................ 37 2.3.3 Malaysia ............................................................................................................. 38 2.3.4 The Philippines ................................................................................................... 39 2.3.5 Singapore ............................................................................................................ 40 2.3.6 Thailand .............................................................................................................. 40 2.3.7 Summary of Regulations on RP Disclosure ....................................................... 41

2.4. Conclusion .................................................................................................................... 43

CHAPTER 3: LITERATURE REVIEW ............................................................................ 45

3.1 Information Asymmetry and Financial Disclosure ....................................................... 45 3.1.1 Agency Theory and Information Asymmetry .................................................... 45

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3.1.2 Information Asymmetry and Disclosure ............................................................ 46 3.1.3 The Motivation for Related Party (RP) Transactions and RP Disclosures ......... 49

3.2 Nature and Extent of Corporate RP Transactions and RP Disclosures ........................ 51 3.2.1 RP Transactions – U.S. Studies .......................................................................... 51 3.2.2 RP Transactions – Asia-Pacific Studies ............................................................. 53

RP Disclosure Transparency .............................................................................. 54 General RP Transactions ................................................................................... 55 Specific RP Transactions .................................................................................... 56 Summary of RP Transactions – Asia-Pacific Studies ......................................... 59

3.3 Factors Influencing Corporate Related Party Disclosure.............................................. 60 3.3.1 Internal Corporate Governance Characteristics .................................................. 60

Board Characteristics ........................................................................................ 61 Ownership Characteristics ................................................................................. 65

3.3.2 External Corporate Governance Characteristics – Firm Level ........................... 69 Leverage ............................................................................................................. 69 External Auditor ................................................................................................. 70 Cross-listing Status ............................................................................................. 70

3.3.3 External Governance Characteristics – Country Level ...................................... 71 Disclosures and Country of Origin .................................................................... 71 Disclosures, Legal Systems, and Cultural Values .............................................. 73 Disclosures and Enforcement ............................................................................. 74

3.3.4 Other Firm-Specific Factors Associated with Corporate Disclosure ................. 76 3.4 Conclusion .................................................................................................................... 77

CHAPTER 4: THEORETICAL FRAMEWORK AND HYPOTHESES

DEVELOPMENT ................................................................................................................. 79

4.1 Theoretical Framework – Agency Theory .................................................................... 79 4.2 The Nature and Extent of RP Transactions and Disclosures across Countries

(RQ1) ............................................................................................................................ 81 4.3 The Extent of RP Disclosure Conformance to IAS 24 within and between

Countries (RQ2) ........................................................................................................... 82 4.4 Research Framework and Hypotheses Development (RQ3) ........................................ 84

4.4.1 Internal Corporate Governance Mechanisms and RP Disclosure ....................... 86 Board Characteristics ........................................................................................ 86 Board Independence ........................................................................................... 86 Board Size........................................................................................................... 88 Board Expertise .................................................................................................. 89 Audit Committee Characteristics ....................................................................... 90 Audit Committee Independence .......................................................................... 91 Audit Committee Size .......................................................................................... 92 Audit Committee Expertise ................................................................................. 93 Ownership Concentration .................................................................................. 94 Family-Controlled .............................................................................................. 95

4.4.2 External Corporate Governance Characteristics and RP Disclosure .................. 96 Leverage ............................................................................................................. 96 External Auditor ................................................................................................. 97 Listing Status ...................................................................................................... 98 Country-level Factors ......................................................................................... 98 Legal Origin ....................................................................................................... 99 Enforcement ........................................................................................................ 99 Investor Protection ........................................................................................... 100 Control for Corruption ..................................................................................... 100

4.4.3 Other Firm-Specific Factors (Control Variables) and RP Disclosures ............. 101 Company Size ................................................................................................... 101

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Performance and Profitability .......................................................................... 102 RP Transaction Activity .................................................................................... 102 Industry Type .................................................................................................... 103

4.5 Conclusion .................................................................................................................. 103

CHAPTER 5: RESEARCH DESIGN ............................................................................... 105

5.1 Sample Selection and Data Sources............................................................................ 105 5.2 Overall Research Specification ................................................................................... 107

5.2.1 RQ1: Classification and Measurement of the Information about RP Transactions ...................................................................................................... 108

5.2.2 RQ2: Development of RP Disclosure Index .................................................... 110 Applicability of RP Disclosure Items across Countries ................................... 111 Validation of the Disclosure Index ................................................................... 112 Weighting and Scoring the Disclosure Indices................................................. 112

5.2.3 RQ3: Regression Model for Testing the Determinants of RP Disclosures ...... 116 5.2.4 Explanation and Justification of Independent Variables .................................. 119

Internal Governance Characteristics ............................................................... 119 BIND: Board Independence (H1) ..................................................................... 119 BSIZE: Board Size (H2) ................................................................................... 119 BEXP: Board Expertise (H3) ........................................................................... 119 ACIND: AC Independence (H4) ....................................................................... 120 ACSIZE: AC Size (H5) ..................................................................................... 120 ACEXP: AC Expertise (H6).............................................................................. 120 CONC: Ownership Concentration (H7) ........................................................... 120 FAM: Family-Controlled (H8) ......................................................................... 120 Firm-Level External Governance Characteristics ........................................... 121 LEV: Leverage (H9) ......................................................................................... 121 EXT: Type of External Auditor (H10) .............................................................. 121 CROSS: Cross-listing Status (H11) .................................................................. 122 Country-level Governance Characteristics ...................................................... 122 LEGL: Legal Origin (H12) ............................................................................... 122 ENF: Enforcement (H13) ................................................................................. 122 INVP: Investor Protection (H14) ..................................................................... 123 CORUP: Control for Corruption (H15) ........................................................... 123

5.2.5 Control Variables ............................................................................................. 124 SIZE: Company Size ......................................................................................... 124 PERFORM: Performance ................................................................................ 124 PROFIT: Profitability ...................................................................................... 125 NRPT: RP Transaction Activity........................................................................ 125 INDUS: Industry Type ...................................................................................... 125

5.2.6 Summary of Dependent and Independent Variables (RQ3) ............................. 125 5.2.7 Diagnostic and Sensitivity Tests ...................................................................... 128

Normality and Other Regression Issues ........................................................... 128 Sensitivity Analysis (RQ3) ................................................................................ 128

5.3 Conclusion .................................................................................................................. 129

CHAPTER 6: RESULTS ................................................................................................... 131

6.1 The Nature and Extent of RP Transaction and RP Disclosures (RQ1) ....................... 131 6.2 The Extent of RP Disclosure Conformance to IAS 24 (RQ2) .................................... 138 6.3 Factors Influencing the Nature and Extent of RP Disclosures (RQ3) –

Descriptive .................................................................................................................. 143 6.3.1 RP Disclosure Indices ...................................................................................... 144 6.3.2 Independent Variables: Firm-Level Internal Governance Characteristics ....... 147 6.3.3 Control Variables ............................................................................................. 150

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6.4 Univariate Analysis .................................................................................................... 153 6.5 Multivariate Test: Results of Hypothesis Testing (RQ3) ........................................... 157

6.5.1 Board Characteristics (H1-H3) ......................................................................... 159 6.5.2 Audit Committee Characteristics (H4-H6) ....................................................... 159 6.5.3 Ownership (H7-H8) .......................................................................................... 160 6.5.4 Firm-Level External Governance Characteristics (H9 - H11) .......................... 161 6.5.5 Country-Level External Governance Characteristics (H12 - H15) .................. 162 6.5.6 Control Variables ............................................................................................. 163

6.6 Robustness Tests and Sensitivity Analysis ................................................................. 163 6.6.1 Alternative RP Disclosure Indices (MSCORE2).............................................. 163 6.6.2 The Influence of Legal Protection (LEGL) ...................................................... 165 6.6.3 Alternative Measures for Investor Protection (ADRI and ASDI) .................... 166 6.6.4 The Influence of Culture (SECRECY) ............................................................. 167

6.7 Conclusion .................................................................................................................. 169

CHAPTER 7: CONCLUSIONS ........................................................................................ 173

7.1 Summary and Discussion of Findings ........................................................................ 173 7.1.1 Findings on the Nature and Extent of RP Transactions (RQ1) ........................ 176 7.1.2 Findings on the Nature and Extent of RP Disclosures (RQ2) .......................... 177 7.1.3 Findings on the Determinants of RP Disclosures (RQ3) .................................. 177

7.2 Contributions and Implications ................................................................................... 180 7.3 Limitations and Future Research ................................................................................ 183

APPENDICES ..................................................................................................................... 184

Appendix 1 Model Accounts of RP Disclosures by Big 4 Accounting Firms ...................... 184 Appendix 2A Correlation – Australia ................................................................................... 186 Appendix 2B Correlation – Indonesia .................................................................................. 187 Appendix 2C Correlation – Malaysia ................................................................................... 188 Appendix 2D Correlation – Philippines ................................................................................ 189 Appendix 2E Correlation – Singapore .................................................................................. 190 Appendix 2F Correlation – Thailand .................................................................................... 191 Appendix 3A MSCORE Within-Country ............................................................................. 192 Appendix 3B DSCORE Within-Country .............................................................................. 193 Appendix 3C OSCORE Within-Country .............................................................................. 194 Appendix 4 Additional Regression Analysis – Replacing Country-Factors with

Country-Dummies (N=582)........................................................................................ 195

BIBLIOGRAPHY ............................................................................................................... 196

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LIST OF TABLES

Table 2.1 Comparative Institutional Factors Affecting Accounting Disclosures ................... 17

Table 2.2 History of IAS 24 Related Party Disclosure ........................................................... 31

Table 2.3 Extent of Conformance to IAS 24 and Relevant Regulatory Authority in

Fiscal Year 2009 ..................................................................................................... 35

Table 2.4 Comparative Related Party Disclosure Requirements in 2009 ............................... 42

Table 4.1 Summary of The Research Hypotheses (RQ3) ..................................................... 104

Table 5.1 Sample Selection and Country Breakdown .......................................................... 106

Table 5.2 Sample Distribution across Industries................................................................... 107

Table 5.3 Classification of Related-Parties and Related-Party Transactions ........................ 110

Table 5.4 Related-Party IAS 24 Disclosure Checklist .......................................................... 113

Table 5.5 Discretionary Disclosure Coding System ............................................................. 115

Table 5.6 Country-Level Governance Factors ...................................................................... 124

Table 5.7 Summary of the Variables, Measures and References .......................................... 126

Table 6.1 Descriptive Statistics of RP Transactions by Nature Across Countries ................ 134

Table 6.2 Descriptive Statistics of RP Transactions by Nature of Related-Party

Relationships Across Countries ............................................................................ 137

Table 6.3 Corporate Conformance with the Mandatory RP Disclosure Items ...................... 139

Table 6.4 Corporate Conformance with Additional Mandatory/Discretionary

Disclosure Items ................................................................................................... 141

Table 6.5 Companies Disclosure of Items that are Discretionary in All Countries .............. 143

Table 6.6 Descriptive Statistics for the RP Disclosure Indices ............................................. 144

Table 6.7 Multiple Comparisons of Mean Differences for the RP Disclosure

Indices .................................................................................................................. 146

Table 6.8 Descriptive Statistics for Firm-Level Governance Characteristics as

Independent Continuous Variables ....................................................................... 149

Table 6.9 Descriptive Statistics for Continuous Control Variables ...................................... 151

Table 6.10 Descriptive Statistics for Dichotomous Control Variables ................................. 153

Table 6.11 List of Variables Used in the Model of RP Disclosures ..................................... 154

Table 6.12 Correlations of Independent and Dependent Variables ...................................... 155

Table 6.13 Results of Regression Analysis on the Association between RP

Disclosures and Governance Characteristics (N=582) ......................................... 158

Table 6.14 Additional Regression Analysis – Alternative MSCORE (N=582) .................... 164

Table 6.15 Additional Regression Analysis – Excluding Legal Origin (LEGL)

(N=582) ................................................................................................................ 165

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Table 6.16 Additional Regression Analysis – Replacing INVP with ASDI (N=582) .......... 167

Table 6.17 Additional Regression Analysis – Inclusive of SECRECY (N=582) .................. 169

Table 7.1 Summary of Hypotheses and Findings ................................................................. 179

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LIST OF FIGURES

Figure 4.1 Research Framework ............................................................................................. 85

Figure 5.1 Overall Research Specification ........................................................................... 108

Figure 6.1 Mean of RP Disclosure Indices (Mandatory, Discretionary and Overall

Index) .................................................................................................................... 147

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LIST OF ABBREVIATIONS

AASB Australian Accounting Standards Board

ADB Asian Development Bank

A-P Asia-Pacific

ASEAN Association of Southeast Asian Nations

ASX Australian Securities Exchange

ASX CGC Australian Securities Exchange Corporate Governance Council

BAPEPAM-LK The Capital Market and Financial Institutions Supervisory Agency

CCDG Council on Corporate Disclosure and Governance

CCG Code of Corporate Governance

CFA Chartered Financial Analyst

CG Corporate Governance

CPI Corruption Perception Index

ESO Executive Stock Option

FAS Financial Accounting Standard

FRC Financial Reporting Council

FRQ Financial Reporting Quality

FRS Financial Reporting Standards

GDP Gross Domestic Product

IAI Indonesian Institute of Accountants

IAS

IASB

International Accounting Standard

International Accounting Standards Board

IASC International Accounting Standards Committee

ICR International Country Risk

IDX Indonesia Stock Exchange

IFRS International Financial Reporting Standard

IPO Initial Public Offering

JSX Jakarta Stock Exchange

KLSE Kuala Lumpur Stock Exchange

KMP Key Management Personnel

MAS Monetary Authority of Singapore

MAS Malaysian Accounting Standard

OECD Organisation for Economic Co-operation and Development

PAS The Philippines Accounting Standards

PSE The Philippines Stock Exchange

RP Related Party

RPT Related Party Transaction

SEC The Securities and Exchange Commission

SET Stock Exchange of Thailand

SGX Singapore Stock Exchange

USD U.S. Dollar

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STATEMENT OF ORIGINAL AUTHORSHIP

The work contained in this thesis has not been previously submitted to meet

requirements for an award at this or any other higher education institution. To the

best of my knowledge and belief, the thesis contains no material previously

published or written by another person except where due reference is made.

Signature :

Date : June 17, 2013

QUT Verified Signature

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ACKNOWLEDGEMENTS

All praises and thanks are due to Almighty Allah, who has given me abundant

blessings for making this work possible.

First and foremost, I would like to express my sincere gratitude to my PhD

supervisors, Prof. Gerry Gallery and Prof. Natalie Gallery who have provided me

with relentless guidance, motivation, and immense knowledge in all the research and

writing of this thesis. Their advice at every stage was instrumental in my thesis

completion. This thesis would not have been accomplished without their persistent

support. I am also sincerely grateful to my PhD review panel: Prof. Marion

Hutchinson and Dr. En Te (John) Chen for their encouragement and insightful

comments on the drafts of this thesis.

I gratefully acknowledge the full financial support provided by the Japan-Indonesia

Presidential Scholarships (JIPS) of the World Bank Institute (WBI). Great thanks to

Ms. Marie Grossas and Mr. Karim Gigler at the WBI for their assistance. I also thank

QUT Business School for providing me with a top-up graduate scholarship and the

Centre for Good Corporate Governance (CGCG) at the Faculty of Economics and

Business Universitas Gadjah Mada (FEB UGM) for all their support and study leave.

I wish to thank Prof. Ann Tarca, Prof. Phillip Brown, and Prof. Graeme Dean for

their helpful suggestions and encouragement during the early stages of my PhD

research. I also thank Prof. Helen Irvine, Dr. Belinda Luke, and Dr. Roushi Low for

their kind motivation and encouragement. Thank you also to the staff in the School

of Accountancy and QUTBS for all their assistance during my stay in the PhD

program. I also wish to thank my fellow PhD graduates (Angela, Kim and Kevin),

PhD students (Tao, Vienh, Sharmin, Linh, Cuong, Abdalla, Ross, Wendy and Iwan),

and also all my friends in IISB and PPIA-QUT for their indispensable support and

encouragement. Great thanks to Jane Todd for her help in editing this thesis.

For all the boundless patience, sacrifices, and unwavering support from my dear

husband, Dr. Syaiful Ali, thank you very much. Both of us have decided to embrace

these duo PhD voyages, in pursuit of a better future. To Anya and Iris, my smart and

lively daughters, my apologies for not being fully attentive during these three and

half years. Thank you for your love, prayers, and beautiful chant: you-can-do-it-

mum.

Last but not least, my deepest thanks to my mother for her motivation and sacrifices,

my parents-in-law, and my sisters Isna and Etha. This journey would not have been

possible without their unconditional love and support.

To my beloved father in heaven, who passed away in the first year of my study, I

dedicate this thesis with all my heart. You are my guru in life and after.

Chapter 1: Introduction

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CHAPTER 1: INTRODUCTION

Understanding the nature, extent, and consequences of related-party (RP)

transactions and the disclosure about those transactions by companies in the Asia-

Pacific Region is the focus of this study. International Accounting Standard (IAS) 24

Related Party Disclosure defines an RP transaction as “a transfer of resources or

obligations between related parties, regardless of whether or not a market price is

charged” (IAS 24, para 9). Parties are considered to be related if one party has the

ability to control the other party or exercise significant influence over the other party

in making financial and operating decisions, for example a controlling shareholder, a

director, key management personnel, or affiliated companies, controlled entities, and

entities under common control. The critical issue is that RP transactions might not be

undertaken at market prices, primarily due to the influence of the relationship

between the two sides to a transaction, that is, the company and the related party. For

example, the transactions may be conducted using favourable prices or terms and

conditions, instead of using market prices or normal commercial terms and

conditions.

Ideally, RP transactions between companies within a group can increase cost-

effectiveness to meet a firm’s specific economic needs (Gordon, Henry, & Palia,

2004a). However, for both controlling shareholders and insiders, such as

management, RP transactions can be the mechanism of self-dealing or insider

opportunism, whereby private benefits of control can be extracted at the expense of

other shareholders (Djankov, La Porta, Lopez-de-Silanes, & Shleifer, 2008; Gordon,

Henry, & Palia, 2004a, 2004b; McCahery & Vermeulen, 2005). From prior research,

an examination of links between the nature of RP transactions and firms’ governance

mechanisms and institutional framework in which firms operate is essential in order

to understand the contrasting motivations for RP transactions.

Currently, companies in Asian countries are identified as having potentially higher

risk of opportunistic RP transactions given their unique institutional setting (Loon &

De Ramos, 2009; OECD, 2009). Asian countries generally have the characteristics of

family concentrated ownership, weak control for corruption, enforcement and

protection of minority shareholders. Family-controlled firms can be more efficient,


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leading to better performance than firms with other ownership forms (Anderson &

Reeb, 2003a; Villalonga & Amit, 2006), particularly given the benefit of reciprocal

relations between the family and the business (Chrisman, Chua, & Sarma, 2003;

Sarma, 2004). However in other settings, family-owned firms may suffer from

inefficiencies, particularly in the absence of strong enforcement and protection of

minority shareholders, because such a setting allows greater opportunity for

controlling owners to pursue private benefits at the expense of minority shareholders’

interests (Heugens, Essen, & Oosterhout, 2009). It is argued that such self-interested

practices contributed to the 1997 – 98 Asian financial crisis, as managers engaged in

a high level expropriation of cash and tangible assets through RP transactions

(Johnson, Boone, Breach, & Friedman, 2000). Accordingly, firms’ commitments to

fully disclose RP information is important to enable investors and other users of

financial statements to monitor and assess the impact of the transactions on a firm’s

performance (Gordon, Henry, & Palia, 2004b). However, the negative perception of

RP transactions as means of opportunisms may lead managers to refrain from

disclosing details of information about these transactions since they may want to

avoid public criticisms. Therefore, it is argued that appropriate regulation and

enforcement mechanisms are warranted to ensure transparent RP disclosures

(Djankov et al., 2008; Loon & De Ramos, 2009; OECD, 2009).

Despite the frequency and growth in concerns, uncertainties, and implications of RP

transaction and disclosure, there has been little academic research to inform market

participants and regulators about the effectiveness of RP disclosures.

1.1. Research Motivations

This study is motivated by a number of factors. First, there has been a general lack of

comparative RP transaction research in the Asia-Pacific region. Extant studies have

mainly focused on the larger and more economically significant countries in the

Asia-Pacific region, such as Australia (Gallery, Gallery, & Supranowicz, 2008),

China (e.g., Berkman, Cole, & Fu, 2009; Cheung, Jing, Lu, Rau, & Stouraitis, 2009;

Jian & Wong, 2010), and Hong Kong (Cheung, Qi, Rau, & Stouraitis, 2009; Cheung,

Rau, & Stouraitis, 2006). These studies tend to focus on specific types of RP

transactions and the wealth effect of the transactions in a single country setting. In

addition, no prior study has conducted a comprehensive and systematic examination


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on the extent of corporate RP disclosure in accordance with RP disclosures standards

on a regional basis.

Second, corporate financial reporting transparency in the Asia-Pacific region became

increasingly important following the 1997-98 Asian financial crisis, particularly as

poor corporate transparency was identified as a key factor behind the crisis (Morris

& Gray, 2009). The 2009 Corruption Perception Index (CPI) produced by

Transparency International shows that the indices for countries in the Asia-Pacific

region range from the cleanest to the most corrupt with ranks from 3 to 139 out of

180 (Transparency International, 2009a)1. This variability in transparency raises the

questions of what is behind the differences and what can countries learn from each

other in the region.

A third factor motivating this study is the importance of understanding the influence

of both country-specific and firm-specific (governance and other) factors on

corporate RP disclosure transparency. The adoption of the International Financial

Reporting Standard (IFRS)2 in almost 100 countries may not result in higher quality

financial statements, if country level factors, such as legal systems, are more

dominant constraints than firm-level factors (Morris & Gray, 2009; Preiato, Brown,

& Tarca, 2012).

Fourth, the nature of and motivation for firms entering into RP transactions in the

Asia-Pacific region vary from those in other regions, particularly those in developed

countries. In developed economies, companies tend to have diffused ownership with

clear separation between ownership and control. However in Asia, companies have

distinct ownership structures which are likely to be concentrated in a single group;

family or the state (Carney & Child, 2012; Claessens, Djankov, & Lang, 2000; Loon

& De Ramos, 2009). Accordingly, senior management and board positions, including

1 A country/territory CPI Score indicates the degree of public sector corruption as perceived by business people

and country analysts, and ranges between 10 (highly clean) and 0 (highly corrupt). The score is based on 13

corruption assessment sources developed by different international agencies. For the Asia-Pacific region, the

2009 scores range from 9.2 for Singapore (rank of 3/180) to 2.4 for the Philippines (rank 139/180) (Transparency

International, 2009a). 2 The International Financial Reporting Standards (IFRS) which are developed by the International Accounting

Standards Board (IASB) are becoming the global standard for the preparation of public company financial

statements (www.ifrs.com). The specific RP international accounting standard (IAS) is IAS 24 Related Party

Disclosure. The terms ‘IFRS’ and ‘IAS’ will be used interchangeably in this study.


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the chairperson and chief executives, are often filled by family members (in family-

owned enterprises) or political appointees (in state-controlled entities) (Carney &

Child, 2012; Claessens et al., 2000). These ownership structures in Asia may lead to

different types of agency conflicts than those in other regions, such as conflicts

between majority and minority shareholders which may lead to different types of RP

transactions (Loon & De Ramos, 2009; OECD, 2009).

1.2. Research Questions

Drawing from the research issues and motivations mentioned above, this study aims

to investigate the nature and extent of RP disclosures by companies in the Asia-

Pacific region through addressing three primary research questions:

1. What is the nature and extent of related party transaction and related-party

disclosures across countries in the Asia-Pacific region?

2. To what extent do the related-party disclosures by companies in the Asia-

Pacific region conform to the IAS 24 Related Party Disclosure within and

across countries?

3. What are the governance, country, and other firm-specific factors which

explain the nature and extent of related-party disclosures by companies in the

Asia-Pacific region?

1.3. Theoretical Framework and Hypotheses

This study builds upon prior literature and uses an agency theory framework in

addressing the three research questions. Agency theory posits that the separation of

ownership and control between the agent and the principal leads to agency problems

when agents act opportunistically to maximise their wealth at the expense of

principals (Berle & Means, 1932; E. Fama & Jensen, 1983; Jensen & Meckling,

1976). The theory posits that this problem occurs because of goal incongruence

between owners and managers, or because of information asymmetry between

owners and managers that restricts the owners from fully monitoring the agents.

Information asymmetry gives rise to moral hazard when managers, who are usually

better informed than the owners, pursue their own interests which deviate from those

of the owners. This situation of goal misalignment leads to agency costs (Jensen &

Meckling, 1976). It is argued that one way to reduce such costs is through a greater


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disclosure in financial statements. A firm’s commitment to disclose will enable

shareholders to monitor their interests more efficiently and can provide a signal that

the managers act in the interests of the shareholders (Healy & Palepu, 2001). Prior

studies suggest corporate governance can act as monitoring mechanisms to mitigate

information asymmetries and agency problems between managers and investors

(Bushman & Smith, 2003; Farinha, 2003; Gillan, 2006; Larcker, Richardson, &

Tuna, 2007).

Consistent with agency theory, a review of the literature in Chapter 3 identifies that

RP transactions can be efficient business transactions that fulfil a firm’s economic

needs, or transactions that serve the interests of managers and therefore represent a

conflict of interest between management and shareholders (Gordon, Henry, & Palia,

2004a, 2004b). Under the agency theory framework, it is argued that opportunistic

RP transactions can facilitate managers/insiders’ opportunistic behaviours,

particularly given the non-arms-length nature of such transactions. In this case,

firms’ disclosure of RP transactions can be one way to increase monitoring of such

transactions. However, companies tend to disclose information if the benefits of

disclosures outweigh the costs of withholding such information (Healy & Palepu,

2001). Therefore, given the sensitive nature of RP transactions, firms may refrain

from disclosing opportunistic RP transactions to avoid the costs of releasing such

information. Accordingly, firms’ decisions to disclose RP transactions may be

influenced by the type of RP transactions. When RP transactions are efficient

transactions, the benefits of fully disclosing these transactions are more likely to

outweigh the costs.

The agency theory framework also posits that, given the potential agency costs, both

the owners and managers of the firm have incentives to strengthen monitoring

systems in the firm to minimise such costs. Corporate governance mechanisms are

part of monitoring systems to minimise agency problems and ensure that managers

act in alignment with shareholders’ interests. Effective corporate governance can

help safeguard an optimal firm’s disclosure policy (e.g., Shleifer & Vishny, 1997).

Assuming that effective corporate governance mechanisms can improve firms’

monitoring of managers, such mechanisms are expected to result in less opportunistic

RP transactions and more transparent disclosure of such transactions. Consistent with

this expectation, prior studies find that better-governed firms are associated with


~ 6 ~

more frequent disclosures of price-sensitive information (Beekes & Brown, 2006)

and greater RP disclosures (Utama & Utama, 2012). Full disclosure of RP

transactions enables shareholders to monitor their interests more efficiently and can

provide a signal that managers act in the interests of the shareholders, consistent with

the agency theory framework.

Within this framework, three research questions and 15 research hypotheses are

developed to address the study’s objectives. Eleven hypotheses address the influence

of firm-level internal and external governance characteristics, while four hypotheses

address the influence of country-level factors, on the extent of RP disclosures.

1.4. Research Design

This thesis focuses on related-party disclosures by companies in the Asia-Pacific

region in annual reports for the financial year ending 2009. In particular, this study

focuses on comparing the disclosure of RP transactions in selected Asian-Pacific

countries, namely Australia, Indonesia, Malaysia, the Philippines, Singapore, and

Thailand. These countries account for a range of differences in legal systems

(common or code law), ownership characteristics, and the nature of the regulatory

frameworks (Carney & Child, 2012; Claessens, Djankov, & Lang, 2000; Djankov et

al., 2008; La Porta, Lopez-De-Silanes, & Shleifer, 2006; Morris & Gray, 2009;

Morris, Susilowati, & Gray, 2012; Tipton, 2009).

The year 2009 is selected to capture the existing differences in the institutional

environment of RP disclosure. In 2009, Australia, Malaysia, the Philippines and

Singapore mandated the IAS 24 (2003), whereas Indonesia and Thailand used an

earlier version of IAS 24. In the same year, the IASB issued an amended/revised

version of IAS 24 (2009), which would be effective from 1 January 2011.

Accordingly, the year 2009 is selected since the disclosure in the annual reports

preceded the changes in the disclosure requirements in the six countries. In addition,

the 2009 annual reports were the most recent reports available in all six countries at

the time of data collection for this thesis. A one year study period was chosen due to

the complexity of controlling for the changes in institutional differences and their

consequences over time and across countries3.

3 A similar argument is made by Aerts and Tarca (2010) in their international disclosure study.


~ 7 ~

The research methods in addressing the research questions and hypotheses consist of

descriptive/exploratory analysis and multivariate testing of the RP disclosures of 582

selected firms from the top 100 largest non-financial companies in each country,

based on the OSIRIS-BVDEP list of market capitalisation as at 31 December 2009.

The selected firms have fulfilled the selection criteria that they provide RP disclosure

in the 2009 annual reports, to enable comparison of the level (extent) of RP

disclosures in the period of 2009.

The extent of RP disclosure index is measured using a self-constructed RP

disclosures index (RP_DISC) based on IAS 24 Related Party Disclosure. The RP

disclosure index (RP_DISC) is represented by three alternative measures of the RP

disclosure scores, that is, mandatory score of RP disclosures (MSCORE),

discretionary score of RP disclosures (DSCORE), and overall score of RP disclosures

(OSCORE).

The multivariate cross-sectional regression model was developed to investigate the

influence of firm- and country-specific factors (independent) on the extent of RP

disclosures (dependent). Additionally, robustness checks are performed to ensure the

reliability of the findings. The independent variables consist of firm-specific

governance characteristics (i.e., the independence, size, and financial expertise of

board of directors and audit committee, ownership concentration, family-controlled

firms, leverage, audit firm size, and cross-listing status) and country-specific

characteristics (i.e., country legal origin, enforcement, investor protection, and

control for corruption).

1.4.1 Definition of Terms Used for RP Transactions and RP Disclosures

In this study, RP disclosures are examined in the context of compliance with the

requirements of the International Accounting Standard (IAS) 24 Related Party

Disclosure. This standard requires companies to disclose related parties,

compensation of key management personnel and the nature of transactions. At the

the minimum level, the disclosures should include the monetary amount of

transactions, the amount of outstanding balances, provision of doubtful debts related

to the outstanding balances, and the expense recognised during the period in respect

of doubtful debts due from related parties. Detailed information for each category of

related party is required in order to facilitate a comprehensive analysis of RP


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transactions. In this study, disclosure conformance is determined using a RP

disclosure index and therefore it is discussed in terms of the level (i.e., extent) of

conformance.

With respect to the RP transactions, this study refers to the transactions between

related-parties which are reported in the companies’ annual reports, for instance,

sales to related-parties, purchases from related-parties, or related-party loans. The

examination of the nature (i.e., the types) and extent (i.e., the dollar amount and the

number) of RP transactions is conducted in accordance with a codification list of RP

transactions, focusing on the nature of RP transactions and the nature of relationships

between related parties.

1.4.2 Scope of Accounting Regulations

This study focuses on the Related Party Disclosure in relation to the requirements

contained in the International Accounting Standards (IAS) 24 Related Party

Disclosure applicable at the beginning of 2009 in all countries of study. Accordingly,

this study refers to the domestic accounting standards in each of the sample

countries, namely AASB 124 (Australia), PSAK 7 (Indonesia), FRS 124 (Malaysia),

PAS 24 (the Philippines), FRS 24 (Singapore), TAS 47 (Thailand). Those domestic

accounting standards are derived from IAS 24 Related Party Disclosure. A detailed

discussion about these standards is provided in Chapter 2.

1.5. Main Findings

The descriptive-comparative analysis on the nature and extent of RP transactions

indicate that RP transactions are common across countries. Of the six countries,

companies in Thailand report the highest number of RP transactions, followed by

Indonesia, Malaysia, Australia, Singapore and the Philippines. Among all types of

RP transactions, RP loans are the most common type of transactions. Relative to the

other countries, Thailand and Indonesia report a higher number of RP loans, which in

many cases are unsecured, interest-free, and repayable on demand. With respect to

the nature of RP relationship, RP transactions with corporate combinations (i.e.,

subsidiaries, associates and joint venture) are common in all six countries. RP

transactions with entities under common control are only reported by companies in


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Indonesia, Malaysia, the Philippines, and Thailand, indicating the dominance of

family-controlled firms in these countries4. RP transactions with director-related

entities are more frequently reported in Thailand and Australia.

The findings are also consistent with the expectations that corporate RP disclosure

conformance to IAS 24 Related Party Disclosure differs across the Asia-Pacific

countries (RQ2). The results reveal considerable country variations in the extent of

RP disclosure conformance to IAS 24 by companies in the Asia-Pacific region. Of

the six countries, Singapore shows the highest conformance to the mandatory

requirements, followed by Australia, Malaysia, Thailand, Indonesia and the

Philippines. With respect to the discretionary aspects of the RP disclosure

requirements, Thailand shows the highest average, followed by Indonesia, Australia,

Singapore, Malaysia and the Philippines. As for the overall disclosure, Australia has

the highest average, followed by Singapore, Malaysia, Thailand, Indonesia and the

Philippines. The findings also indicate that companies appear to be more reluctant to

disclose information regarding RP balances, which is concerning, given the high

number of RP loans reported by companies in the Asia-Pacific region.

The results of multivariate analysis support the expectation that the extent of RP

disclosures by companies in the Asia Pacific region are associated with both firm-

and country-specific factors of internal and external governance characteristics

(RQ3). First, the findings reveal the influence of internal governance characteristics

on the extent of corporate RP disclosures. In particular, smaller boards of directors

are associated with higher levels of RP disclosures, suggesting that excessively larger

boards may create redundancies and inefficiencies because, as boards grow, the costs

of communication and inaccurate decision-making increases. In addition, a fewer

independent board of directors is found to be associated with greater RP disclosures.

This finding may be attributed to the substitution effects between board

independence as a part of the internal monitoring mechanism and corporate RP

disclosure. Further, companies with more concentrated ownership tend to provide

4 Entities under common control include those under common control, those under a common ultimate holding

company, other entities within the group, an entity under common key management, an entity under a common

major shareholder, a subsidiary of an immediate holding company, an entity subject to common significant

influence, wholly-owned subsidiaries of the company’s immediate and ultimate holding company, and a

subsidiary of a holding company.


~ 10 ~

greater RP disclosures. Similarly, family-controlled companies are more likely to

have higher levels of RP disclosures. Thus, family-controlled and high ownership

concentration firms appear to be more transparent in their disclosures of RP

information.

Second, the findings also indicate the influence of external governance

characteristics on the corporate disclosure of RP information. Specifically, the size of

a firm’s external auditor (as measured by Big 4/non-Big 4 grouping) is positively

related with the level of RP disclosure. Larger external audit firms tend to encourage

client firms to be more transparent in their RP disclosures. With respect to the

country-level governance characteristics, stronger control for corruption is likely to

encourage greater or more transparent disclosure of RP information. Furthermore,

companies in a country with stronger enforcement are also more likely to provide a

higher level of overall RP disclosure, suggesting that the more active enforcement

bodies are likely to encourage greater disclosure transparency of RP information.

However, the strength of a country’s investor protection has an inverse relationship

with RP disclosure. One possible explanation is that the investor protection index

only captures the de jure legal system in a country, which will not be effective in the

absence of effective law enforcement. Therefore, the enforcement mechanism

appears to work better, particularly in Asian countries, than the investor protection

mechanism. A robustness check on the alternative measure of investor protection

provides support for this possible explanation.

Taken together, the findings reveal that: (1) corporate RP transactions are common in

the Asia-Pacific region, however they vary by the nature of transactions and by the

nature of RP relationships; (2) the extent of RP disclosure conformance to IAS 24

varies across countries in the region; (3) the extent of RP disclosures by companies

in the Asia-Pacific region is influenced by both firm- and country-level factors; (4) in

the firm level, the extent of RP disclosures is negatively associated with board

independence and board size, and positively associated with ownership

concentration, family-controlling ownership, Big 4 auditor, and RP transaction

activity; and (5) in the country-level, greater RP disclosures are associated with the

level of enforcement, investor protection, and control for corruption.


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1.6. Contributions

Overall, this study’s findings provide a number of contributions to understanding the

nature and extent of corporate RP disclosure transparency and the firm- and country-

specific factors associated with the disclosure. More broadly, this study contributes

to the literature in a number of ways. First, this thesis extends prior studies on RP

transactions which tend to focus more heavily on the “transactions”, either the

amount or number of specific or general transactions, rather than on the

“comprehensive disclosure transparency” of RP transactions. This thesis is among

the first in pursuing the understanding of both of the nature and extent of RP

transactions as well as the comprehensive disclosure transparency of such

transactions using cross-countries setting. The cross-countries approach is beneficial

in informing the influence of country-level factors on the extent of corporate RP

disclosures. The study’s findings show that the country-level factors influence the

disclosure transparency of RP information by companies in the Asia-Pacific region.

Second, this thesis also provides empirical evidence on the link between accounting

and corruption in a cross-country setting. There is a lack of research in this area.

Malagueño, Albrecht, Ainge, and Stephens (2010, p. 375) contend that “[T]here is

little cross country research that establishes a direct empirical link between

accounting and corruption”. The evidence shows that less corrupt countries are

associated with greater disclosure transparency of RP information. This finding

supports previous studies in other areas which find that corrupt actions are more

likely to be discovered when there is greater business transparency (Halter, Arruda,

& Halter, 2009). The findings also suggest that in the absence of efficient control for

corruption, RP transactions are more prevalent as a means of acquiring self-

interested benefits.

Third, the findings of the study confirm the reports by OECD (2009, pp. 40–41) and

CFA (2009, p. 37) which raise the issue of the effectiveness of board independence

for companies in Asian countries5, particularly in relation to RP transactions. The

findings reveal that some of the mechanisms (found to be associated with disclosure

in other studies) were not associated with the extent of RP disclosures by companies

5 For example, Hong Kong Exchange’s chief executive Paul Chow once mentioned that one challenge of

corporate governance in Hong Kong is that non-executive independent directors may not be fully independent

when major shareholders appoint the directors (Loon & De Ramos, 2009, p. 37).


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in the Asia-Pacific region. The findings may suggest that such governance

characteristics are not effective in encouraging RP disclosure transparencies by

companies in this institutional setting. A more effective supervision and regulation

may be required to ensure the efficacy of internal governance mechanisms as an

internal monitoring system in a company, particularly given the costly investment

expended by companies in establishing such mechanisms. For example, the number

of boards on which an independent director may serve can be limited and the concept

of independence can be reinforced, which is consistent with the recommendations by

OECD (2009, pp. 40–41). In addition, a limitation should also be imposed on the

duration of time that an independent can be appointed on the board as mentioned in

the CFA report, “Because no limits exist on the number of times independent

directors may serve on the board, their partiality is also prone to diminishing over

time” (Loon & De Ramos, 2009, p. 37).

Finally, the findings of this study provide important implications for standard setters

and regulatory bodies in relation to a RP disclosure standard. In particular, the

study’s findings show that the country-level factors, including the strength of

enforcement by accounting regulatory bodies, the protection of minority shareholders

against self-dealing actions, and the control for corruption influence corporate

transparency of the RP disclosures. The disclosure of RP transactions, either in the

form of mandatory or discretionary disclosures, is an essential component in

strengthening the protection of minority shareholders, investors and other users

relying on the financial statements as a legitimate source of information in their

decision-making process (Lo & Wong, 2011). In this respect, the transparent RP

disclosures enable users to better monitor transactions that may not be in accordance

with shareholders’ best interests. As an implication, a more stringent RP accounting

standard and RP disclosure requirements are warranted to enhance the disclosure of

RP transactions, particularly as higher standards of RP disclosure are likely to

strengthen the mitigation of opportunistic RP transactions and increase disclosure

transparency. Thus, the findings can help policy makers, particularly in the Asia-

Pacific region, in articulating better RP disclosure requirements for listed companies.


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1.7. Organisation of the Study

The remainder of this thesis is organised as follows. Chapter 2 examines the

institutional setting of countries in the Asia-Pacific region, focusing on the

institutional factors potentially associated with RP transactions and the transparency

of RP disclosures. Chapter 3 presents a review of the RP transactions literature

relevant to this study. Chapter 4 develops the theoretical framework, research

questions and research hypotheses. Chapter 5 describes the research design including

the study period and sample selection, data sources, hypotheses testing procedures,

and regression models. Chapter 6 presents the descriptive results on the nature and

extent of RP transactions, the descriptive statistics, univariate results, and the

multivariate results relating to the hypotheses. This thesis concludes in Chapter 7

with a summary and discussion of the study’s major contributions, recommendations

for future studies, limitations and implications.

Chapter 2: Institutional Setting

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CHAPTER 2: INSTITUTIONAL SETTING

A country’s accounting and financial reporting in a country is influenced by its

environment (Belkaoui & Alnajjar, 2006; Ruland, Shon, & Zhou, 2007).

Specifically, accounting quality and practices are influenced by firm-, market-, and

country-level factors; including legal and cultural environments, and accounting

standard setting (Ball, Robin, & Wu, 2003; Biddle & Saudagaran, 1989; Rahman,

2006). Among those factors, differences in legal systems have a profound effect on

the approach to accounting and financial reporting (Ball et al., 2003; Epstein &

Mirza, 2002). Similarly, both anecdotal and empirical evidence suggest that different

institutional factors are likely to affect the nature and extent of related party (RP)

transactions and RP disclosures (Djankov et al., 2008; Loon & De Ramos, 2009;

OECD, 2009).

RP transactions are presumably normal transactions, as emphasised in IAS 24 (Para.

5): “Related-party relationships are a normal feature of commerce and business. For

example, entities frequently carry on parts of their activities through subsidiaries,

joint ventures and associates”. Based on this presumption, RP transactions are

efficient transactions to obtain specific economic needs and rationally fulfil the

economic demands of a company (efficient transaction hypothesis) (Gordon, Henry,

& Palia, 2004a, 2004b). However, owing to the nature of the relationship between

the entity and the related party, these parties may enter into transactions that are not

on “arm’s-length” terms. The non-arm’s length term of RP transactions provides the

opportunity for an agent to pursue personal interest at the expense of the principal’s

interest (opportunistic or conflict-of-interest hypothesis) (Gordon, Henry, & Palia,

2004a, 2004b). Corporate governance systems and the economic environment, in

which the firm operates, influence the economic rationale of a firm to enter into RP

transactions (Pizzo, 2009). Additionally, previous studies on RP transactions suggest

that a firm’s decision regarding RP transactions and their disclosures are associated

with the firm’s ownership structure (Cheung, Qi et al., 2009), accounting regulation

(Arshad, Darus, & Othman, 2009) and, importantly, institutional factors (Djankov et

al., 2008; Jian & Wong, 2010).


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This chapter presents an analysis of institutional factors across countries that are

relevant to this study and documents the accounting regulation affecting RP

disclosures. Section 2.1 examines institutional factors associated with RP

disclosures, including ownership concentration, capital market development, the

legal system and corporate governance principles. Section 2.2 discusses the evolution

of international accounting standards on RP disclosures. Section 2.3 outlines the

development of RP disclosure standards in selected Asia-Pacific countries. Finally,

the chapter finishes with a conclusion in Section 2.4.

2.1. Country Factors Associated with RP Disclosures

An extensive line of research suggests that country-specific factors play an essential

role in influencing accounting practices and incentives (for example, Ball, 2006;

Ball, Kothari, & Robin, 2000; Biddle & Saudagaran, 1989; Doupnik & Salter, 1995;

Perera, 1989; Ruland et al., 2007)6. Perera (1989, p. 41) argues that “accounting is a

product of economic environment, and a particular environment is unique to its time

and locality”. In addition, a country’s accounting practices are influenced by the

structure and level of its capital market development (Biddle & Saudagaran, 1989).

Similarly, Doupnik and Salter (1995) suggest that external environment and

institutional structure have significant influences on the development of accounting

standards. Further, Ball et al. (2000) find that the role of accounting information is

less effective in environments with low investor protection and a more concentrated

ownership.

Unlike current RP transactions studies, which tend to focus on the United States or

other developed economies, this study focuses on Asia-Pacific countries, which

provide a unique setting to investigate RP disclosures. First, firms in the Asian

setting are commonly characterised by dominant shareholders and family ownership

(Claessens et al., 2000; La Porta, Lopez-de-Silanes, & Shleifer, 1999). Notably,

Indonesia, Malaysia, Thailand and the Philippines have a relatively higher number of

family-controlled firms than the other countries. Second, Asia-Pacific countries also

differ in legal origin, capital market development, enforcement, control for

6 Ball et al. (2003) suggest that managers’ incentives in preparing financial reports are influenced by the

interaction between the market and political forces in the reporting country. Market forces include the amount of

publicly traded equity, the size of the market for public debt and the extent of private versus public contracting.

Political forces include the extent of government involvement in codifying and enforcing accounting standards.


~ 16 ~

corruption, and corporate governance structures, including capital market

development and strength of law enforcement. While those unique characteristics

provide an important setting to investigate the nature and extent of corporate RP

disclosures (Djankov et al., 2008; Loon & De Ramos, 2009; OECD, 2009), there are

no known prior studies examining these institutional characteristics. This section

identifies and discusses differences in institutional factors across key Asia-Pacific

countries that are relevant to RP transactions and their disclosures.

Table 2.1 presents comparative institutional factors affecting accounting disclosures

in the countries of study; discussion of those factors follows.


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Table 2.1 Comparative Institutional Factors Affecting Accounting Disclosures

Countries Legal

Origin

Stock

Market

Cap./GDP

Enforcement

Index

Investor

Protection

Index

Anti-Self-

Dealing

Index

Control for

Corruption

Index

Ownership

Concent.

Family

Ownership

Controlling

Owner

Alone

Management

Australia Common Law 128.8% 11 0.784 0.76 8.7 0.28 10.0 n.a n.a.

Malaysia Common Law 132.7% 9 0.729 0.95 4.5 0.52 51.5 76.3 70.9

Singapore Common Law 170.5% 6 0.770 1.00 9.2 0.49 60.2 75.9 74.0

Indonesia Code Law 33.0% 4 0.507 0.65 2.8 0.58 57.3 68.1 58.2

The

Philippines Code Law 49.8% 8 0.812 0.22 2.4 0.57 78.5 66.4 71.0

Thailand Code Law 52.3% 7 0.373 0.81 3.4 0.47 37.8 65.9 65.2

Note: Legal origin is the origin of legal system of commercial code or company law in each country (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1998, p.

1122 citing Reynold & Flores, 1989); Stock Market Cap./GDP is the stock market capitalisation as a percentage of GDP (ADB, 2010, p. 200); Enforcement

Index is an index measuring cross-country differences in the enforcement of accounting standards in 2008 which ranges from 0-12, in which 12 is the strongest

enforcement (Preiato et al., 2012); Investor Protection Index is a country’s securities regulation an index concerning legal protection of shareholders, which

consists of the principal component of the indices of disclosure requirements, liability standards, and anti-director rights (La Porta et al., 2006); Anti Self-Dealing

Index represents the protection of outside shareholders against self-dealing by insiders or controlling owners, which consists of ex-ante control, ex-post control,

and public enforcement of anti-self-dealing practices (Djankov et al., 2008); Control for Corruption Index is a 2009 corruption perception index by Transparency

International which ranges from 0-10 in which 10 is the cleanest from corruption (Transparency International, 2009a). For each proxy of enforcement, a higher

score implies stronger enforcement. Ownership Concentration is the average ownership stake of the three largest shareholders among its 10 largest publicly

traded companies (La Porta et al., 1998, pp. 1146-1147). Family is the number of firms controlled by family – using 10% as the criterion for control -- in a given

country. Family ownership data for Australia is taken from La Porta et al. (1999, p. 493); whereas those of the other five countries are taken from Carney and Child

(2012, p. 12). The sample of La Porta et al.’s (1999) dataset consists of top 20 firms ranked by market capitalisation of common equity at the end of 1995. The

sample of Carney and Child’s dataset consists of the top 200 largest firms by stock market capitalisation at the end of 2008 for which the ultimate ownership could

be traced accurately. Controlling Owner Alone equals one if there is not a second owner who holds at least 10% of the stock, zero otherwise (Carney & Child,

2012, p. 15). Management equals one if the CEO, board chairman, or vice chairman are from the controlling family, zero otherwise (Carney & Child, 2012, p. 15).


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2.1.1 Legal Origin

Table 2.1 identifies the legal origin of each country, distinguishing between common

law and code law legal origins, following the classification of La Porta et al. (1998)

and La Porta et al. (2006)7. The legal systems of Australia, Malaysia and Singapore

are originated from common law, whereas those of Indonesia, the Philippines and

Thailand are from code law8.

Code law is rooted in Roman law and has a greater emphasis on codes and statutes

established by legal scholars (La Porta et al., 1998 citing Merryman, 1969). In

contrast to the Code law, Common law – which originated in England – has a greater

reliance on the precedents of judges’ decisions on particular disputes (La Porta et al.,

1998). Through colonisation, the Common law legal origin was disseminated to the

U.K. and British colonies including, for example, the U.S., Canada, Australia and

India (La Porta et al., 1998).

The financial reporting system in a country may be influenced by its legal origin

(e.g., Archambault & Archambault, 2003). A review on international accounting

research by Meek and Thomas (2004, p. 29) suggests that “the international

accounting literature has recognised for at least 30 years that accounting in common

law countries differs from accounting in code law countries”9. Prior studies have

provided evidence on the link between countries’ legal origin and accounting

practices and disclosures10. La Porta et al. (1998) classify countries into the British

common law and the family of civil law legal origins (i.e., French, German and

Scandinavian) and report that the legal origin in a country influences its accounting

standards, shareholders’ rights and capital market development. Specifically, La

Porta et al. find that law enforcement and shareholders’ protection are typically

stronger in countries with British common law origins than in countries with French

civil law. Consistent with this notion, Jaggi and Low (2000) find that firms in

common law countries tend to have greater financial disclosures than those in code

7 La Porta et al. (1998, p. 1119) note that, “Thailand’s first laws were based on common law but since received

enormous French influence”. This thesis classifies Thailand as a civil/code law country, which is also consistent

with Nenova, Claessens, and Djankov (2000). 8 As mentioned in Jaggi and Low (2000, p. 499, also citing Ball, 1998 and Ball et al., 1998), “The civil law

countries have also been referred to as code law countries.” This thesis uses the code law terminology. 9 Further, Meek and Thomas (2004, p. 29) also cite previous literature (e.g., Nobes, 1983; Berry, 1987; and

Doupnik & Salter, 1993) that “The legal basis for accounting differences is a significant input into proposed

classification of accounting systems worldwide.” 10 For example, Archambault and Archambault (2003); Ball, Kothari and Robin (2000); Ball, Robin and Wu

(2003); Hope (2003a, 2003b); Jaggi and Low (2000); La Porta et al. (1998).


~ 19 ~

law countries. Hope (2003b) also finds a positive association between common law

legal origin and the levels of annual report disclosure. In addition, the accounting

systems in common law countries tend to be more fairly presented, have greater

transparency and a higher level of disclosure than those in code law countries (Meek

and Thomas, 2004, p. 29).

Compared to code law countries, common law countries generally have more

developed capital markets and greater mandatory disclosure requirements which

include the disclosure of RP transactions (La Porta et al., 2006, p. 6). Additionally,

Djankov et al. (2008) find that the common law countries tend to have stronger

regulations concerning the mitigation of companies’ self-dealing compared to the

worldwide average. Following the findings of the previous studies, common law

legal origins are expected to influence greater disclosure transparency.

Table 2.1 also shows country differences in the development of capital market, the

strength of enforcement, level of protection for investor, and control for corruption.

2.1.2 Capital Market Development

A country’s legal origin may also affect the development of its capital market. La

Porta, Lopez-de-Silanes, Shleifer, and Vishny (1997) find that the size and extent of

a country’s capital markets are associated with their legal environment – that is, both

legal rules and their enforcement. “[A] good legal environment protects the potential

financiers against expropriation by entrepreneurs; it raises their willingness to

surrender funds in exchange for securities, and hence expands the scope of capital

markets” (La Porta et al., 1997, p. 20). La Porta et al. (1997) find that common law

countries are associated with more developed capital markets and stronger investor

protections than code law countries. More recently, La Porta et al. (2006) developed

a disclosure index and examined the association between the index and stock market

development across 49 countries around the world. The disclosure index includes

insiders’ compensation, ownership by large shareholders, inside ownership, contracts

outside the normal course of business, and transactions with related parties (La Porta

et al., 2006, pp. 10-11). They find a strong positive association between the

development of capital markets and disclosure requirements, suggesting that a


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developed capital market tends to have a more extensive disclosure requirement,

including the disclosure of transactions with related parties11.

Table 2.1 shows the average stock market capitalisation across six countries in 2009,

measured by the percentage of stock market capitalisation relative to Gross Domestic

Product (GDP). The stock market capitalisation of Australia, Malaysia and Singapore

exhibits higher ratios than the other three countries, which may indicate that these

three countries have more developed capital markets relative to the others.

Djankov et al. (2008) investigate the influence of anti-self-dealing regulation on the

development of capital markets across 72 countries around the world and find

positive associations between capital market developments and the anti-self-dealing

regulation12.

Based on the findings in La Porta et al. (2006) and Djankov et al. (2008), these more

developed capital markets are expected to have more regulations concerning RP

transactions and greater requirements of RP disclosures.

2.1.3 Enforcement, Investor Protection and Control for Corruption

In addition to the legal origin and capital market development, prior research in other

areas of international accounting (e.g., earnings management) provides evidence on

the association between the quality of accounting and the strength of enforcement

(Ball et al., 2003; Hope, 2003a; Preiato et al., 2012), investor protection (Durnev &

Kim, 2005; Francis & Wang, 2008; Leuz, Nanda, & Wysocki, 2003), and control for

corruption (Kimbro, 2002; Malagueño et al., 2010). Table 2.1 shows the differences

in the strength of enforcement, investor protection and control for corruption across

the selected Asia-Pacific countries.

Enforcement

The quality of financial information is influenced by both the quality of accounting

standards and the effectiveness of the enforcement of these accounting standards

(Kothari, 2000). Ball (2006) argues that the quality of the enforcement of standards is

11

La Porta et al. (2006) use seven proxies to measure the development of the stock market, including the ratio of stock market

capitalisation to GDP scaled by the fraction of the stock market held by outside investors. They note that “the results are

qualitatively similar for the unadjusted ratio of market capitalisation to GDP” (La Porta et al., 2006, p. 13) 12

The stock market development is represented by a ratio of stock market capitalisation to GDP (Djankov et al., 2008, p. 445).


~ 21 ~

a more credible signal of financial reporting quality rather than the standards per se,

because assuring high enforcement standards would alter local political and

economic interests. Stronger enforcement will ensure that disclosure requirements

can provide better access to basic financial information (Morris & Gray, 2009). In a

poor enforcement environment, a high quality disclosure requirement alone is not

sufficient in developing high quality financial reporting, despite it being an essential

step (P

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